New research shows that rising prices is the biggest concern going into 2017 for over one in five UK SMEs.
It comes as the latest figures from the Office for National Statistics (ONS) show that inflation went up to 1.6% in December, from 1.2% in November.
The findings of the Q4 SME Confidence Tracker from Bibby Financial Services reveal that 22% of SMEs say rising costs is their biggest concern for the year ahead. The number of businesses that see rising costs as a significant challenge has doubled over the past 12 months.
These fears are of particular concern for manufacturers with almost a third (29%) citing this as their biggest challenge. Increasing competition (18%) and late payments (11%) are the other key challenges highlighted by SMEs.
It means many small businesses are currently focusing on finding cost efficiencies instead of investing for growth, according to the research. Over a quarter (28%) of SMEs said that they were holding off on investing in their businesses due to concerns about the UK economy.
David Postings, global chief executive of Bibby Financial Services, said: "Rising costs fuelled by inflation and the drop in the value of the pound is a double-edged sword for many businesses. The manufacturing industry has recently grown at the fastest rate for 25 years, fuelled by an uplift in exports due to the pound's depreciation, but manufacturers that are reliant on importing goods and selling solely in the UK will see margins being significantly eroded.
"These businesses are facing the challenge of maintaining profitability while remaining price competitive," he said. "This equation is causing a headache for many businesses and we are seeing many SMEs start to tighten their belts and pull back investment. In little over six months we have seen investment intentions from SMEs halve."
Commenting on the latest inflation figures, Suren Thiru, head of economics at the British Chambers of Commerce (BCC), said: "We expect inflation to surpass the Bank of England's 2% target in the coming months, reaching around 2.5% by the end of the year."
James Sproule, chief economist at the Institute of Directors (IoD), agreed that it was "only a matter of months before we break through the Bank of England's 2% target".
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